The Bearish Case for Apple

by Jeff Reeves | August 22, 2012 6:00 am

Apple (NASDAQ:AAPL[1]) rolled back on Tuesday from its record high hit on Monday. So is it a sell?

I know, I know — what a knee-jerk reaction. But I’ve written before that my threshold for selling a stock is simple: Look at it in a vacuum, as if you’ve never owned it, and do your analysis. Would you buy it now? If so, then keep it — because it’s still worth buying. If not, then sell it and seek out a better stock.

Apple isn’t immune to this logic. And since I am a shareholder in Apple (I bought most recently on the dip to $550 this spring), I figure I would take my own advice and try to make a bearish case for Apple. If a logical argument can be made, it would be time to take at least some of that profit off the table and see if it’s time to move my money to a more profitable stock.

Here’s the bearish case for Apple stock, as best as I can tell:

Valuation Creep: The stock has a forward P/E of about 12.4 based on fiscal 2013 estimates of around $52.50 in earnings per share. That’s OK, but not exactly cheap. The fiscal 2012 P/E is around 14.9 — fair, but not attractive enough to scream “buy.”

Targets Moving Down?: Those P/E calculations assume that the 2013 forecast remains steady, however. Some analysts have been subdued with their earnings targets for next year following lackluster Q3 earnings[2] and disappointing guidance for Q4. A poor showing could spark a widespread rollback in next year’s expectations.

iPad Dominates, but Hurts Mac Sales: The “new iPad[3]” launch created some buzz, but also some complications. After all, a post-PC age doesn’t mean only Dell (NASDAQ:DELL[4]) and Hewlett-Packard (NYSE:HPQ[5]) are out of luck — many reports indicate the tablet is cannibalizing Mac sales[6]. Much in the way the rise of the iPhone eventually made the iPod a rounding error in Apple’s business, the iPad is quickly pushing Macs to the periphery. That places a lot of pressure on AAPL to keep its tablet business on top and growing in the face of Microsoft (NASDAQ:MSFT[7]) and its Surface tablet[8] and the Google (NASDAQ:GOOG[9]) Android-powered Nexus tablet[10].

iPhone 5 Is Make It or Break It: There’s no question that Apple’s dominance in the smartphone market isn’t just on a technology/brand level but also on a profitability level.

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This chart says it all – that while other gadget makers may be producing smartphones, they don’t mark them up as much as Apple. And with the iPhone accounting for 50% of Apple’s revenue, the importance of the next iPhone can’t be overstated. If the company can’t keep up its huge margins and its huge market share, it will be painfully obvious.

Tech Dominance Doesn’t Last: A lot of hooey was made about Apple eclipsing the largest market cap in history[12] when it topped $623 billion. However, it’s worth noting that the previous peak of $619 held by Microsoft at the height of the dot-com era, was most certainly a bubble. Adjusted for splits, MSFT stock was almost $60 during those glory days, but has had trouble even breaking through $35 over the last decade. Countless other tech stocks soared and then died, and it’s naïve to think Apple will only go up.

Technological Disruption: Even if rivals can’t figure out the tablet space or the smartphone space, who’s to say something better won’t come along in the next few years? There’s an ever-present threat of a new product or technology that will upend the smartphone world, just as the mobile revolution hung so many other companies out to dry.

So that, as clearly as I can make it, is the bearish case on Apple. If it can’t maintain its iPad dominance or the big margins on its iPhones, the top line is going to see some pain. And if past is precedent, those on top of tech never stay there for long, so Apple’s days may be numbered. Add that up with a valuation that is only so-so, and there are reasons not to chase this stock.

So should I sell? If I was a short-term trader, maybe. It’s hard to imagine Apple going up another 50% from here in the next six to 12 months.

But as a long-term investor, I’ve just gotten my first taste of Apple dividends. And even if it maintains a forward P/E of 12.5 on what’s expected to be fiscal 2014 earnings of $62 or so, that means it gets to $775 by the end of 2013 for another 20% upside from here.

I’m not so greedy that I’ll thumb my nose at a 20% gain and a modest dividend along the way. So I’m hanging on to Apple.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[13] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he held a long position in Apple.